You Can Always Come Up With a Reason For Why the Stock You Are Researching is Actually About to Go Out of Business

Someone who reads the blog sent me an email asking how Quan and I judge qualitative factors like a company’s durability.

For most stocks, you can easily imagine a future condition that would obsolete the entire business model.

I’ve decided to make this post nothing but a series of examples.

 

John Wiley

Open access journal articles.

There is a whole Wikipedia page about this one. The idea here is that someone else will pay the cost of publishing journals in place of the subscriber.

 

Weight Watchers

Apps.

Dieters will use free apps like MyFitnessPal to count calories instead of going to meetings or using websites like Weight Watchers.

 

HomeServe

Illegal marketing.

Without aggressive marketing aimed at old people – would this product even exist? You can read about the FCA (a U.K. regulator) fine imposed on HomeServe and the reasons for it here.

 

Ark Restaurants

Leases expire.

Ark may not renew its leases because the casino or other landlord would want to charge a lot more rent now that the location and the restaurant is a proven success. So, Ark as a corporation has a finite lifespan except insofar as management reallocates capital to new sites.

 

Village Supermarket

Online groceries.

Traditional supermarkets have 3 durability risks people raise: 1) Online groceries 2) Wal-Mart 3) Organic and fresh competitors: The Fresh Market, Whole Foods, etc.

 

America’s Car-Mart

Securitization.

America’s Car-Mart sells used cars so it can collect interest on high risk auto loans. The difficult parts of the business are underwriting and collecting loans. If this could be centralized – as it is in lower risk subprime auto loans – then the loans would become commodities.

 

PetSmart

Online dog food.

The two concerns here are that places like Wal-Mart can sell more dog food and websites like Petflow can sell more dog food.

 

Atlantic Tele-Network

Guyana can take away their monopoly.

 

Greggs

British shoppers will stop frequenting high streets. Or, they will eat healthier food instead.

 

Progressive

Self-driving cars will eliminate accidents and therefore the need for auto-insurance.

 

Babcock & Wilcox

U.S. utilities will shift away from coal power plants – which use boilers – toward natural gas, wind, and solar power plants which don’t use boilers.

The U.S. Navy could stop using: nuclear powered aircraft carriers, nuclear powered ballistic missile submarines, and nuclear powered attack submarines.

 

Swatch

People will wear products like the Apple Watch instead.

 

Movado

Same.

 

Fossil

Same. Plus, Michael Kors may be a fad.

 

Western Union

Online competitors like Xoom can replace agent location based money transfers.

 

Hunter Douglas

Big box retailers like Home Depot and Lowe’s can sell blinds in their stores. Blinds can be sold online. As a result, people will stop going to the independent dealers that Hunter Douglas gets all its sales through.

 

Strattec

Smart keys and push to start ignitions can eliminate the need for locks and keys used in car doors and the steering column.

 …

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Babcock & Wilcox Sets Spin-Off Dates

Babcock & Wilcox (BWC) has set the dates for its spin-off. Those who own the stock on June 18th will get their spin-off shares on June 30th:

“As a result of the spin-off, Company stockholders can expect to receive as a dividend one share of New B&W common stock for every two shares of the Company’s common stock held as of 5:00 p.m. EST on June 18, 2015, the record date. The distribution of New B&W shares is expected to occur on June 30, 2015 and is expected to be tax-free. “

Shareholders will then own two separately traded stocks. The stock with the “BWXT” ticker will be the government business. The stock with the “BW” ticker will be the power plant business.

The press release gives an accurate description of what “BWXT” will be:

“BWXT is the sole manufacturer of naval nuclear reactors for submarines and aircraft carriers; provides nuclear fuel to the U.S. government; provides technical, management and site services to aid governments in the operation of complex facilities and environmental remediation activities; and supplies precision manufactured components and services for the commercial nuclear power industry.”

It gives a poor description of what “BW” will be:

“New B&W will continue to be a leader in clean energy and environmental technologies for the power and industrial sectors. New B&W also will provide one of the most comprehensive platforms of aftermarket services to a large global installed base of power generation facilities.”

BW is really the boiler business. They build boilers and related equipment for power plants. Some of those plants are clean energy plants – but a great many are actually coal power plants.

Babcock & Wilcox was a Singular Diligence stock pick. I own the stock personally. Quan does not. I plan to keep both my “BWXT” shares and “BW” shares indefinitely.

I’ll let you know if that changes.…

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Our November 2013 Issue on Life Time Fitness

Life Time Fitness (LTM) now trades at $71.86. The company’s board unanimously agreed to be taken private at $72.10 a share in cash. The merger is expected to close on June 10th. It is now May 19th. So, I’m going to call this one effectively over as a public company.

Quan and I did an issue on Life Time Fitness for Singular Diligence (back when it was called The Avid Hog) in November 2013. The stock price was then $48.51 a share. We appraised it at $79.69 per share.

With the stock trading right below the going private price – the value’s been fully sucked out of this idea.

So, we might as will give the issue away now.

Enjoy.…

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When Should You Diversify?

Someone who reads the blog sent me this email:

 

“I have been thinking about portfolio construction lately. 

…due to the strict standards you have, I thought it was very natural to just hold mainly four stocks…unfortunately, this method has shown its short comings lately. Both because of (your) mistake in picking CLUB/WTW instead of the other winners discussed in Avid Hog/Singular Diligence, and also because I am currently getting in touch with a lot more very cheap opportunities in the Asia region…I have also been rereading Buffett’s partnership letters and was reminded he once held like 40 stocks. Even though he concentrated at his top several positions sometimes and also he sometimes put 30% to 40% of his portfolio into the workout category, he did say they usually have fairly large positions (5% to 10% of their total assets) in each of five or six generals, with smaller positions in another ten or fifteen. (This) of course is a far cry from the 20%/25% position sizing we usually talk about…

 

What are your thoughts? Is it actually better to spread our portfolio a bit more?…I am getting more and more the feeling that finding the right stock is not the most important part, but picking the right ones to actually put money in is the key. Would (being) willing to spread a bit more make this key job easier? The very cheap stocks I am finding these days may not fit something you will invest in as they are likely not good buy and hold investments. Yet they are also not exactly like cigar butts, i.e. not of very, very low quality stuff. Is it wise for me to ignore them in my personal portfolio and just pick those that are more like the buy and hold category?”

 

I hold 4-5 stocks because I find that is most comfortable for me. You want to combine an approach that makes enough objective sense to work for anyone in theory with an approach that makes enough subjective approach for you to carry it out in practice. I found owning 20 stocks was not practical for me. I spent more time watching what I owned than coming up with a good list of new stocks to research. I didn’t spend enough time focused on what I was buying. When I owned 20 stocks, I spent too much time on the HOLDING and the SELLING and not enough time on the BUYING. It’s no accident that the only thing we do for Singular Diligence is tell you which stock to buy. We never revisit it. We never tell you to sell. It’s all focused on a one-time buy decision. I think that’s the decision that really matters. If you get that moment right the next 5 years or more will take care of themselves. There’s just a heck of a lot of time spent on stuff other than worrying what to buy next when you have 20 stocks. When you have …

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Swatch’s Moat

The stock picked for the latest Singular Diligence issue was Swatch. Each issue of Singular Diligence includes articles on: 1) Overview, 2) Durability, 3) Moat, 4) Quality, 5) Capital Allocation, 6) Value, 7) Growth, 8) Misjudgment, and 9) Conclusion.

Here is one of those 9 articles – the moat article – from this month’s issue on Swatch.

 

Moat

Swatch, Richemont, and Rolex Will Always Dominate Swiss Watchmaking

Swatch’s moat varies depending on the price category. Swatch’s moat is widest for brands that retail between $800 and $10,000. The moat is narrower for watches that cost more than $10,000 or less than $800. This is because there are several distinct sources of moat in the watchmaking business. The greatest combination of moats happens in the watches in the middle price categories. These watches are expensive enough that the “Swiss Made” label and the brand name are important. However, they are inexpensive enough that manufacturing still involves mass production in some sense for some of the parts. This is not true of very expensive watches. Some watchmakers who focus on watches over $10,000 can make very, very few watches each year. So there are few production advantages in this category. The watches are also so expensive that a boutique mono brand store can be opened in just a few high end retail stores in cities around the world. So distribution power is not as important. Swatch has more production advantages than any other Swiss watchmaker. Rolex also has strong production capabilities as will be explained in a moment. Some other companies – like Richemont – have some production capabilities. They are much more than mere assemblers. But they are not as self-sufficient as they might appear. Swatch is vertically integrated. It does not need any outside company to exist for it to be able to produce its brands.

Let’s start with production. There are no production advantages in low-end mechanical movements that are not “Swiss Made”. A Japanese or Chinese company or a manufacturer of licensed brands that does not care if the watch carries a “Swiss Made” label can easily get a supply of foreign (non-Swiss) mechanical movements. The governments of both China and India encouraged the production of mechanical movements in the hopes of stimulating a domestic watchmaking industry. So, if a watchmaker does not care about the “Swiss Made” label they can buy movements from a Japanese company like Seiko or Citizen or from a movement maker in China or India. As a result, there is no production advantage – no moat for Swatch – in watch categories that do not rely on the “Swiss Made” label. For watches that do rely on the “Swiss Made” label, Swatch has a big production moat. To earn the “Swiss Made” label a watch must meet several requirements. One of these requirements is that the movement must be made in Switzerland. There are very few Swiss movement makers. It is difficult to get information on mechanical movement market share in Switzerland. …

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Sold Town Sports (CLUB); Bought Babcock & Wilcox (BWC)

Today, I sold my shares of Town Sports (CLUB) and put the proceeds of that sale – plus some other cash – into buying Babcock & Wilcox (BWC).

My average cost in Town Sports was $8.84 a share. My average sale price was $6.85. This is a realized loss of 23% over an 11 month holding period.

My average cost in Babcock & Wilcox is $27.06 a share. Babcock now represents 18% of my portfolio. The company will split into two separate stocks later this year. I will hold on to both of those stocks.

I may increase my position in Babcock to about 25% of my portfolio. This depends on whether: 1) I am successful in selling the last of my Japanese net-nets 2) Babcock’s share price does not rise too much.

The four non-Japanese net-nets in my portfolio right now are:

1. George Risk
2. Ark Restaurants
3. Weight Watchers
4. Babcock & Wilcox

These four stocks account for more than 90% of my portfolio.

Toby handles the Singular Diligence model portfolio. This sale has no impact on the model portfolio. Quan also owns Town Sports in his portfolio. Quan did not sell Town Sports and buy Babcock & Wilcox today. If and when Quan makes a change to his portfolio it will be posted here.

The timing of my sale of Town Sports and purchase of Babcock has to do with Babcock – not with Town Sports. Town Sports is the target of an activist campaign. Activist investors control about a quarter of the company’s shares. The board recently adopted a “poison pill” defense and the activists nominated their ticket for this year’s board election. None of these events make it a particularly good time to sell Town Sports. However, we just put out the Babcock & Wilcox issue of Singular Diligence. The publication of that issue freed me up to buy the stock. Quan and I start research on a stock far in advance of the date when that stock appears in Singular Diligence. So, I have been waiting for months to buy Babcock & Wilcox.

It is worth mentioning that I did not – and would not – have sold Town Sports merely to hold cash. I sold Town Sports to buy Babcock. This tells you 3 things:

1. I prefer Babcock over Town Sports
2. I believed Babcock was the strongest stock I did not already own
3. I believed Town Sports was the weakest stock I did own

For example, my sale of Town Sports obviously tells you that I think Weight Watchers is – at today’s price – a stronger stock than Town Sports. Otherwise, I would have sold Weight Watchers instead of Town Sports.

If you subscribe to Singular Diligence you can now read the full issues on both Town Sports and Babcock & Wilcox.…

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Singular Diligence: 8 Archived Issues

These are the 8 archived issues – each is over 12,000 words long – you get immediate access to the moment you subscribe to Singular Diligence.

 

Singular Diligence – Archived Issues

Life Time Fitness (LTM): Runs 112 (mostly) huge gyms across 25 U.S. states. About half (55) of these clubs are on unmortgaged company owned land. Since our report was published, Life Time Fitness announced it may convert to a REIT.

Progressive (PGR): A U.S. auto insurer that competes with GEICO online. Also the largest auto insurer in the independent agent channel.

Ark Restaurants (ARKR): Runs a small number of huge restaurants in landmark locations like: Union Station, Bryant Park, Faneuil Hall, casinos, and hotels. Also has an interest in the Meadowlands racetrack in Northern New Jersey as well as the food and beverage concession there.

Town Sports (CLUB): Runs urban gyms in New York City, Washington D.C., Boston, and Philadelphia under the “Sports Club” name.

HomeServe (London – HSV): A U.K. company that provides home emergency repair services using an insurer’s premium based model. Now also in countries like France and the United States.

John Wiley (JW.A): A publisher of books, textbooks, and academic journals. The vast majority of the company’s value is in its academic journals. The Wiley family has controlled the company for 207 years.

Village Supermarket (VLGEA): The second largest operator of “Shop-Rite” supermarkets. Stores are mostly in densely populated Northern New Jersey. Each store does about $1 million a week in sales

Weight Watchers: (WTW): The world’s biggest weight loss brand. Weight Watchers runs group support meetings, the WeightWatchers.com self-help website, sells Weight Watchers products, and licenses the Weight Watchers name.…

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Babcock & Wilcox (BWC): Considering Separation into Two Companies

Babcock & Wilcox (BWC) just announced it is considering separating into two companies:

“…Board of Directors is evaluating the separation of the Company’s Power Generation Business and Government & Nuclear Operations Business into two publicly traded companies. The Board’s goal is to determine whether a separation creates the opportunity for enhanced shareholder value and business focus. B&W has retained JPMorgan as its financial advisor and Wachtell, Lipton, Rosen & Katz and Jones Day as legal advisors to assist in this process.”

The company reports its results in 4 segments (one of which is the experimental money losing mPower – tiny nuclear generator – business). So it is easy to analyze what the company will look like post any possible break-up. The stock is up 7% as I write this.

It still looks cheap.…

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Adidas Announces Share Buyback

Adidas announced plans to spend up to 1.5 billion Euros over 3 years buying back its own stock. The company will take on debt (it has no net debt) and continue to pay a dividend. Dealbook quotes the company’s CFO as saying:

“We believe that our shares are currently significantly undervalued and this provides an excellent opportunity to optimize the company’s cost of capital, deploy cash and create further value for our shareholders”

(Dealbook)

At the current share price, the company could buy up to 10% of its own shares over 3 years. Bloomberg also has an article on the buyback and it focuses more on the possibility of activist investors targeting the company. The article speculates activists would want the company to replace its CEO and spin-off Reebok and TaylorMade.

Adidas is very cheap compared to its two best known – and expensive – peers: Nike (NKE) and UnderArmour (UA).

Adidas is valued more in line with the company with which it shares a founding family: Puma.

When looking at the history of those 4 companies and their cultures – it is difficult to argue that Adidas is truly comparable to either Nike or Under Armour.

Regardless, Adidas is cheap given the level of stock prices generally and the multiples at which athletic apparel companies normally trade.…

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Hollywood Reporter: Softbank Offers to Acquire DreamWorks Animation (DWA) for $32 a Share

The Hollywood Reporter says the Japanese conglomerate Softbank has made a $32 a share offer to acquire DreamWorks Animation (DWA).

The Hollywood Reporter followed up with some more analysis in a later article.

You can read Bloomberg’s article here.…

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